The last element in this litany applies to contagion risk. We already see contagion at work in Portugal. Credit spreads are telling us that Portugal is the next Greece. It remains to be seen if the market is right or the market is overreacting. We also see contagion signs of trouble in Spanish spreads, in Italian spreads and even slightly with France. The French benchmark 10-year bond now trades over 100 basis points wider than the 10-year German benchmark âbund.â The lessons of losses from holding Greek sovereign debt are fresh. Bondholders of the other countriesâ debt fear repetition with good reason.
No one knows if Greece will leave the Eurozone. Many are privately and contingently preparing for it, while publicly saying they do not want it to happen. Electoral outcomes are unpredictable, even though polling results influence markets. In the end, Greece has already lost. Europe has lost but can still cut further losses if it acts with congruence. We do not expect that to happen in any pro-active way. It is not in the nature of Europeâs political leaders to reach consensus pro-actively. They do so when forced by market events. We must think of European leaders as reactive, not proactive.
âWhen youâre in a hole, stop digging.â 1989 U.S. News & World Report, 23 Jan. CVI. iii. 46 (headline).
The Eurozone leaders had the chance to stop digging when the Greeks restated their macro numbers after they entered the Eurozone. Those leaders were publicly silent, privately enraged as I heard with my own ears, but publicly silent.
Eurozone leaders had another opportunity to stop digging when the Greek government lost its high credit rating. Instead, they bent the rules and permitted Greece to maintain its collateral standing. Eurozone leaders had repeated chances to stop digging as the last two years have unfolded. Eurozone leaders have failed at pro-active decision-making.
They have another chance right now but, so far, they have failed to act decisively. Eurozone leaders continue to extend credit to Greece. The present form is the expansion of the Emergency Liquidity Assistance in Greece. Europeans fear a contagion from bank runs that would collapse the Greek banking system. Meanwhile the ELA is only expanding the liability for the rest of the Eurozone as it waits. At Cumberland, we are tracking the ELA continuously. It is telling a story of accelerated deterioration.
Europeâs contagion risk is high and rising. Banking runs in weaker Eurozone countries are likely to continue. Why would any sane depositor keep her euro in a weak bank while she can move it to a safer bank in another country?
My colleague and Cumberlandâs Chief Global Economist, Bill Witherell, is in Europe and just finished several days at the GIC meetings, which included eight central bankers. Greece and the other periphery were an ongoing topic of discussion.
Bill emailed me his conclusion. âThe decision for Greece exiting is really up to Greece. There is no provision in EC law for kicking a country out. It could be done with a unanimous decision by the EC heads of state. The problem is that Greece wants to stay in but the majority appears not to be willing to follow through with the austerity commitments already made. They will not be able to meet their financing needs without further funds from their creditors. The latter will be quite unwilling to continue to help if Greece refuses to keep its commitments. Is it possible we could see a messy restructuring/default but with Greece remaining in the Eurozone? Portugal Is not Greece no matter what the bond vigilantes may think. I think the Eurozone members, the ECB and the Portugal government will do whatever it takes to see Portugal through a difficult period. The same goes for Spain and Italy. Incidentally, in the Sat. FT there was an article saying over a long time period, half the time Greece was in a default/restructuring situation.â
Thank you to Bill, who responded to my email between airports in Cracow and Paris. Bill will have more to say about Europe in the coming days.
So, when youâre in a hole, stop digging. If you are not in a hole, donât go there.
At Cumberland, we have avoided the âhole.â We do not own peripheral Europe. We have underweighted total Europe but do own some exposure in the north. We are now worried that France can weaken so we do not own Franceâs ETF. We are more worried about Italy, the worldâs third largest debtor. We remain concerned about the outcome in Spain. We fear a reprise of Greek tragedy in Portugal although our base case is that it wonât end in a Portugal default. In any case, we do not own, Greece, Italy, Portugal or Spain and currently are avoiding France.
As for the new drachma, it is not a panacea.
Some Notes follow:
(1) The word panacea has its roots in the Greek word panakeia, which means all healing. Such is the irony of language.
(2) Ancient Macedonia is not to be confused with the present day Republic of Macedonia, a part of the former Yugoslavia.
(3) Macedonian King Philip II, the father of Alexander the Great, united ancient Macedonia with successful military campaigns. He created the platform for his son to conquer the world. Philipâs success 24 centuries ago had two elements that were new to warfare at this time in antiquity. He expanded the use of heavy cavalry. Ancient Macedonia had the ability to support horses in larger numbers than more southern Greek agricultural states. Philip incorporated heavily protected horses in the construction of his Phalanxes. The phalanx is the name of the battle formation used in ancient times. Philip added a long spear (sarissa) to the front lines of the phalanx. It required two hands to hold it and was about 18 feet long. That allowed the first five rows of the phalanx to hold spears as they marched to face the oncoming phalanx. Shorter spears meant only the first two rows of men could use spears to penetrate the opposition.
(4) The island of Delos is famous in Greek mythology. It is also the original seat of the early Greek monetary authority. After the Persian wars, the island became the natural meeting-ground for the Delian League, founded in 478 BC. Those congresses were held in the temple. The Delian Leagueâs treasury was kept on Delos until 454 BC when Pericles moved it to Athens. Thus, we surmise that the original Greek monetary policy was determined on Delos. It must have been successful since the drachma was universally accepted at that time.
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David R. Kotok, Chairman and Chief Investment Officer
Copyright (c) Cumberland Advisors
